25 July 2023

Pension savings in retirement - Part two

With the increased cost of living, people are understandably worried about whether they have a large enough nest egg to sustain the comfortable retirement they have long envisaged. In this two part blog, we will dive into the importance of starting pension contributions early and some of the benefits of continuing pension contributions beyond your employment retirement.

The second part focuses on adding contributions once retired:

Adding to pensions once retired

The thought of making further contributions to a pension once you have retired from your employment is alien to most people. Mainly because people associate their employment retirement, with accessing their pension. The two don’t necessarily happen simultaneously. Pensions remain a lucrative option for saving funds even after you stop working.

To highlight the benefit of this, allow me to talk you through an example. Under current rules, an adult in the UK is allowed to contribute up to the higher of their earnings (capped at £60,000) or £3,600 per tax year. So if you have zero income in a tax year following retirement, then you can still contribute £3,600. This amount can come from savings you have built up or received previously. As we discussed in part 1, to incentivise individuals to save into pensions and be self-sufficient in retirement, the Government give savers basic rate income tax relief in the form of an additional contribution (higher and additional rate taxpayers can apply for their extra tax relief via their self-assessment tax return). So, if you pay in £3,600 into a pension, it effectively only costs you £2,880. The remaining £720 is the 20% tax relief funded by the Government. The latest age you can pay into a pension is 75.

A compelling case

To show the power of this seemingly simple planning point, imagine doing this for 10 years from retirement at age 65 until age 75. Assuming a growth rate of 5% pa on the underlying fund, the end value would be £47,265. This would have only cost you £28,800 in cumulative contributions, meaning a profit of £18,465. £7,200 of this is tax relief from the Government and the remaining £11,265 is the cumulative 5% per annum investment growth.

To further emphasise the benefit, any unspent pension funds on death are not subject to Inheritance Tax (IHT) at 40%. Whether or not you are liable to IHT depends on the value of your taxable estate (pensions are not included in this). Using the above figure of £47,265 this is a further tax saving of £18,906 which would have been due on death had this money been saved in a bank account as it would be in your taxable estate.

Twice the benefit

If there are two of you in the household, the combined value of paying in £2,880 each for ten years would be:

  • £14,400 income tax relief
  • £37,812 Inheritance Tax saved
  • £22,530 growth (assuming 5% per annum investment return)
  • £94,530 total end value
  • £57,600 cost to you

So, to use the example of a couple who have more income or capital than they need and are concerned about a possible IHT bill on death, it is really worth considering pensions as a savings vehicle in retirement. Even if you decide to draw money from the pension later, 25% is tax-free and the rest is taxed at your marginal rate of income tax, which in retirement is likely to be lower than during your working life.

If you would like to speak about any aspect of retirement planning, please contact the author Iain Harper, Associate Director at Carbon.

The value of investments and the income derived from them can fall as well as rise. You may not get back what you invest.

This communication is for general information only and is not intended to be individual advice. It represents our understanding of law and HM Revenue & Customs practice. You are recommended to seek competent professional advice before taking any action.

Tax and Estate Planning Services are not regulated by the Financial Conduct Authority.

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